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Required Reading for New Commissioners (Part 3)

We are discussing Commissioner Aguilar's recent public statement, Commissioner Aguilar's (Hopefully) Helpful Tips for New SEC Commissioners.  

The talk also highlighted an inevitable reality of life as a commissioner.  Despite having final say on all matters resolved by the Commission, commissioners confront the reality that an extraordinary amount of responsibility is either delegated to the staff or exercised by the staff in the form of informal advice.  As his statement notes, this is necessary given the complexity and breadth of Commission activities.   

  • From time to time, you might read in a newspaper about a “Commission action,” and you will have no idea what it is about. So you’ll ask yourself, am I having a “senior moment?” Am I suffering from amnesia? Probably not. In all likelihood, the staff had taken action pursuant to the more than 376 separate rules where the Commission previously granted delegated authority to the SEC staff.  These delegations have become necessary and have grown over time because individual Commissioners could not realistically handle the tremendous volume of matters that require Commission action. 

Awareness of the authority is important, so is notification by the staff.  As Commissioner Aguilar stated:  

  • This is not to say, however, that the Commissioners should not be notified when the staff takes action on particularly important matters via delegated authority. During my tenure, the staff has improved at giving Commissioners a “heads-up” about notable actions that the staff plans to take using its delegated authority. Nevertheless, there are still times when the staff acted based on delegated authority on important matters (or, at least, important to one or more Commissioners) without notice to the Commissioners. Accordingly, you should familiarize yourself with these delegations.

Where authority has been delegated, a single commissioner can ask to have the matter considered by the entire Commission.  17 CFR 201.431 ("The vote of one member of the Commission, conveyed to the Secretary, shall be sufficient to bring a matter before the Commission for review.").

Matters are also handled informally by the staff but not pursuant to delegated authority.  As Commissioner Aguilar noted:   

  • Speaking of the staff’s powers, be aware of a number of other areas where the staff has authority to act without prior Commission approval. This authority includes, among many other things, the power to issue “no-action,” interpretive, or exemptive relief letters, and to publish staff guidance, such as Staff Legal Bulletins or Staff Accounting Bulletins. 

Individual commissioners have less authority with respect to these positions.  As he noted:  "Unlike staff actions taken via delegated authority, however, individual Commissioners have no power to require that these matters be brought before the entire Commission."

Commissioner Aguilar has served during a formative time at the SEC.  The SEC's oversight responsibilities have become broader and more complex.  The role of individual commissioners has evolved.  His "Helpful Tips" will not replace trial and error as a teaching tool but will provide new commissioners with a much quicker start in becoming active and effective participants in the mission of the SEC.    


Required Reading for New Commissioners (Part 2)

We are discussing Commissioner Aguilar's recent public statement, Commissioner Aguilar's (Hopefully) Helpful Tips for New SEC Commissioners.  

The statement also includes insight into the internal process of the Commission.  Commissioners sometimes vote neither at an open nor closed meeting but by seriatim.  The power to schedule this type of vote apparently falls to the Chair.  As Commissioner Aguilar notes: 

  • Matters are often voted “by seriatim,” which means that these matters are being circulated to each Commissioner’s office in turn, Commissioner-by-Commissioner, for his or her vote. The Chair typically votes last, but given that the Chair decides whether to circulate a seriatim in the first instance, it is reasonable to assume the Chair will approve it. Seriatims can be tricky because one Commissioner can hold onto a seriatim (a “desk drawer veto,” if you will). Dealing with this usually falls on the Chair, but sometimes you may have a particular interest in seeing a seriatim get voted and approved. In that case, your only options are either to persuade your fellow Commissioner to “move it along” (even if he or she votes to “disapprove” it) or to persuade the Chair to have it voted on at a public open meeting (or, occasionally, in a closed non-public Commission meeting, if allowed under an exemption to the Sunshine Act). Fortunately, under Chair White this hasn’t been a significant issue.

This type of authority facilitates Commission action by allowing decisions to be made in between meetings. The ability to exercise a "desk drawer veto" suggests that these sorts of votes are primarily designed to resolve routine matters.      


Required Reading for New Commissioners (Part 1)

Commissioners at the SEC, when the step down, often slip off quietly as they begin new careers elsewhere. Commissioner Aguilar, in contrast, has provided the Commission and his successors with a parting gift. He issued a public statement that included his advice to future commissioners. See Commissioner Aguilar's (Hopefully) Helpful Tips for New SEC Commissioners.  

The advice comes from an indvidual who has served on the Commission for seven years and served under four different chairs over two administrations (Chairs Cox, Schapiro, Walter & White).  Commissione Aguilar was there when the financial crisis struck and when Congress adopted Dodd-Frank and the JOBS Act.  His perspective is deep and unique.

We will not repeat the entire content of the statement.  There are, however, some very interesting observations that warrant particular mention.  

First, there is the impact of the Sunshine Act.  An idea that sounded good when it was adopted, the Act has had some unintended consequences on agency decision making process. Essentially, most agency meetings must be open to the public.  A meeting is any convocation of the number commissioners needed to make a decision.  See 5 USC § 552b. 

Thus, anytime three of five commissioners meet to discuss agency matters, they are arguably holding a meeting that must be open to the public.  As a result, it is very difficult to discuss agency matters in a collective matter.  As Commissioner Aguilar noted, the task often falls to the staff. 

  • Because of the Government in the Sunshine Act of 1975 (the “Sunshine Act”), your counsels will play a key role in communicating with the offices of other Commissioners and with the staff generally. The Sunshine Act generally requires that any time two or more Commissioners discuss Commission business, it needs to be done in a public forum. (Certain enforcement and administrative matters are excluded from this requirement.) The practical impact of this requirement is that it limits informal discussions between Commissioners and leaves much of the communication to take place between and among the Commissioners’ counsels. As a result, you will lean heavily on your counsels to gather, collect, and process information on your behalf, not to mention the “negotiations by proxy” that can take place among counsels on behalf of Commissioners.

This would invariably happen, with or without the Sunshine Act.  Nonethless, the Sunshine Act presumably increases the instances where negotiations take place in this manner.  



The Growing Costs of Copyright Permissions

I am the co-author of a textbook on Corporate Governance published by Lexis.  The book, although designed for a course that may not exist at most schools, has done well enough to require a second edition.  A dynamic area, plenty of developments have occurred over the last four or so years.  

As part of that process, copyright permission needs to be obtained for articles excerpted in the new edition. This is a laborious task since the textbook uses excerpts from more than 80 articles and books. The excerpts are generally modest in length, ranging from 500 to 1000 words.   

Most law reviews (and authors) are pleased to have an excerpt of their article appear in the textbook. Permission is readily given and free.  The same is true with most law reviews.  

A number of reviews, however, have assigned the task of obtaining copyright permission to the copyright clearance center.  In these circumstances, payment to use an excerpt is required.  In general, the payments are modest in amount, ranging from around $20 to around $60.  In a handful of cases, however, the cost for the excerpt was $200 or more.  The reason for the differential was unclear.  Apparently at least some permissions are based on the number of pages from an article, without consideration of the size of the print run or the actual number of words contained in the excerpt.        

Given the modest print run (the publisher estimates that it will print approximately 500 copies of Corporate Governance) and the modest budget for copyright permissions ($1000), the book cannot afford to absorb very many permissions of $200 or more.  In some cases, law reviews were flexible and willing to adjust the charge. One review waived the fee, another dropped the amount to $100 per article.  In other cases, however, the reviews offered at best modest discounts.  Thus, one review that initially wanted almost $700 for short excerpts from three articles was willing to accept about $500.  

What to do?  One possibility would be to keep all of the articles, pay the fees, and personally absorb the unreimbursed costs.  Another would be to keep only a few of the more expensive articles, perhaps those deemed "classics."  In the end, the decision was not difficult.  In the corporate governance area, there are numerous high quality articles in law journals that do not charge or that charge modest amounts.  Substitutes abound.  The Second Edition will, therefore, have five or six fewer articles from top 10 journals, including the three from the review that offered to take $500.  

Presumably law reviews benefit economically from the current fee structure.  Thus, it may be rational to impose a fee that at least sometimes results in the deletion of articles from a textbook.  Moreover, with the decline in subscriptions, other sources of income may have increased importance. Authors, however, may have a different perspective.  Yet their view was not, at least overtly, a part of the approval process.          


Constitutionality of SEC administrative proceedings 

In Tilton v. SEC, No. 15-cv-2472 (S.D.N.Y. Jun. 30, 2015), the U.S. District Court for the Southern District of New York threw out a lawsuit filed by Patriarch Partners, LLC, the CEO Lynn Tilton, and affiliated companies (collectively “Plaintiffs”), seeking to halt the SEC’s cease-and-desist proceedings. The suit asserted that the administrative proceeding was unconstitutional. The court found it had no subject matter jurisdiction to halt the proceeding against the Plaintiffs.

On March 30, 2015, the SEC brought an administrative cease-and-desist proceeding alleging that the Plaintiffs violated federal securities laws by “providing false and misleading information, and engaging in a deceptive scheme, practice and course of business, relating to the values they reported for these funds’ assets.” []

The Plaintiffs challenged the SEC proceeding in district court contending that since administrative law judges (ALJs) were not appointed by the SEC Commissioners themselves, they violated the Appointments Clause of the Constitution. In addition the two layers of tenure protection created by “for cause” removal protections applied to ALJs at the SEC also violated the Constitution.

The court found that it lacked subject matter jurisdiction to hear the Plaintiff’s case. As the court reasoned:

  • Congress has created a remedial scheme applicable to claims such as Plaintiffs', pursuant to which the exclusive avenue of review of an ALJ's decisions is through the administrative process, with subsequent judicial review by a federal court of appeals. Plaintiffs are therefore obliged to further litigate their claims in the Commission's administrative forum and seek review, if they so choose, in a circuit court of appeals.

Nonetheless, the court would have the authority to hear a collateral challenge to an administrative proceeding “[1] if ‘a finding of preclusion could foreclose all meaningful judicial review’; [2] if the suit is ‘wholly collateral to a statute’s review provisions’; and [3] if the claims are ‘outside the agency’s expertise.’”

The court examined whether the existing system provided for “meaningful judicial review.” Although the issue could be litigated in an administrative proceeding and eventually appealed to the US Court of Appeals, the court considered whether Plaintiffs lacked meaningful review because the approach, among other things, would require them to litigate “through administrative channels” that they claimed were unconstitutional, would not allow them to “effectively” raise their claims and the ALJ and the Commission would “be ‘inherently conflicted’ in assessing their claims.” 

The court however, rejected the arguments. As the court concluded: 

  • Plaintiffs contend that it is unconstitutional-and unfair-for the Commission to subject them to an enforcement action before the Commission's own Administrative Law Judge. But that question is not for this Court to decide. Congress has carefully delineated the distinct roles of the Commission and the courts in cases such as this. It rests first with the Commission to determine whether to commence an action at all, and if so, whether to do so in federal district court or in its own administrative tribunal. Having chosen the latter, it rests with an ALJ and then the Commission to rule on Plaintiffs' claims. That decision in turn is subject to appeal to a federal court of appeals. In this Court's view, there is no basis to allow Plaintiffs to bypass this congressionally created remedial scheme.


Accordingly, the court denied the Plaintiffs’ motion for a preliminary injunction for lack of subject matter jurisdiction.

The case has been appealed. The SEC denied a motion to adjourn pending the outcome of the appeal.[1] The Second Circuit however granted a stay of the administrative proceeding after hearing oral argument Tilton v. S.E.C., No. 15-CV-2472 RA, 2015 WL 4006165, at *1 (S.D.N.Y. June 30, 2015). 

The primary materials for this case may be found on the DU Corporate Governance website




District Court Compels the SEC to Promulgate Final Extraction Payments Disclosure Rule

In Oxfam America, Inc. v. SEC, No. 14-13648-DJC, 2015 BL 284860 (D. Mass. Sept. 2, 2015), Oxfam America, Inc. (“Oxfam”) brought an action to compel the SEC to promulgate a final extraction payments disclosure rule under Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). The United States District Court for the District of Massachusetts granted Oxfam’s motion for summary judgment and denied the SEC’s cross motion for summary judgment. The court held the SEC “unlawfully withheld” action and the appropriate remedy was to compel the agency to comply with its duty to promulgate the disclosure rule.

Section 1504 of Dodd-Frank amended the Securities Exchange Act of 1934, to require publicly traded oil, gas, and mining companies to disclose payments for the commercial development of oil, natural gas, or minerals made to foreign governments or to the federal government. Section 1504 mandated that the SEC promulgate a rule regarding the disclosure requirements by April 17, 2011.

The SEC proposed a rule on December 23, 2010. The proposal received over 150,000 comments. Following delay in issuing the final disclosure rule, Oxfam filed a complaint alleging the SEC unlawfully withheld and unreasonably delayed promulgating the rule. Within two months of Oxfam filing suit, the SEC issued Rule 13q-1 implementing the final disclosure rule. Consequently, the action was dismissed.

In a subsequent action, however, the United States District Court for the District of Columbia held the SEC misread the requirements under Dodd-Frank, vacated the rule, and remanded to the SEC for further proceedings. Am. Petroleum Inst. v. SEC, 953 F. Supp. 2d 5, 25 (D.D.C. 2013)). After remand, the SEC failed to announce a timeline for the promulgation of the new disclosure rule. Oxfam then instituted the action to compel the SEC to issue the final disclosure rule, and both parties moved for summary judgment.

First, the court held the SEC “unlawfully withheld” action by delaying promulgation of the final disclosure rule. An entity governed by the Administrative Procedure Act (“APA”) “unlawfully withholds” action by failing to comply with a statutorily imposed deadline. The duty to act is unfulfilled where agency action is vacated because the vacatur only restores the status quo. Because the SEC was more than four years past Congress’ deadline for promulgating the disclosure rule, and the vacatur did not reset the deadline, the court concluded the SEC “unlawfully withheld” action.

Next, in determining the proper remedy under the APA, the court looked to the test set out in Telecomms. Research & Action Ctr. v. FCC (TRAC), 750 F.2d 70 (D.C. Cir. 1984). The court in TRAC looked to six factors in assessing agency delay. These included consideration of:

the time agencies take to make decisions must be governed by a “rule of reason”; (2) where Congress has provided a timetable or other indication of the speed with which it expects the agency to proceed in the enabling statute, that statutory scheme may supply content for this rule of reason; (3) delays that might be reasonable in the sphere of economic regulation are less tolerable when human health and welfare are at stake; (4) . . . the effect of expediting delayed action on agency activities of a higher or competing priority; (5) . . . the nature and extent of the interests prejudiced by delay; and (6) the [absence of any need to] find any impropriety lurking behind agency lassitude . . .  

The court adopted the Tenth Circuit’s analysis, which found Congress’ use of the word “shall” evinced its intent to remove judicial discretion and thus, required the court to compel agency action. 

Accordingly, the court granted Oxfam’s motion and ordered the SEC to file an expedited schedule for the promulgation of the final disclosure rule with the court in thirty days.

Primary materials for this case may be found on the DU Corporate Governance website.


Acticon AG v. China North East Petroleum Holdings Limited

In Acticon AG v. China North East Petroleum Holdings Limited (“China North”), 2015 BL 278511 (2d Cir. 2015), Acticon AG appealed the district court’s grant of the China North, Wang Hong Jun, Ju Guizhi, Robert C. Bruce, and other defendants’ collectively (“Defendants) motion to dismiss in a securities fraud case. Upon appeal, the Second Circuit vacated the Southern District of New York’s decision in part, affirmed in part, reversed in part, and remanded the case for further proceedings.

 According to the allegations, China North is an oil exploration company operating in the United States and incorporated in Nevada. Acticon filed a civil complaint in the South District of New York against China North, Wang, Ju, and other defendants. It alleged violations of the Securities Exchange Act of 1934 (“Act”), and in particular brought claims under Section 10(b) of the Act and SEC Rule 10b-5 alleging fraud involving scienter. Furthermore, Acticon alleged violations of Section 20(a) of the Act and sought controlling person liability against Wang and Ju.

To raise a strong inference of scienter under Section 10(b) through motive and opportunity, a plaintiff must allege the defendant or its officers benefited from the fraud in a concrete and personal way. When the defendant is a corporate entity, the facts presented must create a strong inference that someone whose intent could be imputed to the corporation, acted with scienter.

Section 20(a) imposes secondary liability for a company’s violations of the Act on executives who are controlling persons in the company. To adequately plead Section 20(b) violations, a plaintiff must show: (1) a primary violation by the controlled person; (2) control of the primary violator by the defendant; and (3) that the defendant was, in some meaningful sense, a culpable participant in the controlled person’s fraud.

The court affirmed the dismissal of the fraud claims requiring a showing of scienter against Ju because there were no allegations he reviewed or signed any of the allegedly false SEC filings. Conversely, the court held Acticon sufficiently alleged scienter against Wang, finding he had both the opportunity and motive to commit the fraud. “As China North's former CEO, Wang signed all of the relevant SEC filings attesting to the company's internal controls, while allegedly simultaneously looting China North's treasury and engaging in unauthorized transfers of company funds.” 

 The court did not analyze the sufficiency of the 20(a) allegations and instead, instructed the district court to do so on remand. The court noted that Wang “may be liable as an individual who controlled China North” and Ju may also be liable “as a director of China North and an alleged participant in the unauthorized transfer”. 

 Finally, the court affirmed the dismissal of claims arising from Section 10(b) of the Act.  for the failure to recognize internal control problems and GAAP violations.  Such failures do not generally “’constitute reckless conduct’”.  Further, the court held that inferences of scienter by defendant Bruce were “weakened by allegations describing his affirmative efforts to uncover fraud by China North.”  

On remand, the district court could permit amendments to the complaint with respect to Wang, Ju, and China North.  As for the other defendants, we affirm the district court's denial of leave to amend. "’[W]here amendment would be futile, denial of leave to amend is proper.’"


The primary materials for this post can be found on the DU Corporate Governance Website



Proposed Amendments to Rule 147.  Importantly, Rule 147 was initially adopted to implement the statutory intrastate exemption found in 1933 Act, §3(a)(11).  As proposed to be modified in Rel. 33-9973, Rule 147 goes beyond §3(a)(11) and would, therefore, be adopted under the SEC’s exemptive authority found in § 28 of the 1933 Act. 

  • The proposed amendments to Rule 147 would permit an issuer to engage in any form of general solicitation or general advertising, including the use of publicly accessible Internet websites, to offer and sell its securities, so long as all sales occur within the same state or territory in which the issuer’s principal place of business is located.   
  • The proposed rules also require that the offering be registered in the state in which all of the purchasers are resident, or be conducted pursuant to an exemption from state law registration in such state that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in a twelve-month period and imposes an investment limitation on investors. This is designed to fit within the state-adopted crowdfunding exemptions, such as the Colorado Crowdfunding Act.  
  • The proposed amendments would also define an issuer’s principal place of business (as opposed to its “principal office” as defined in current Rule 147) as the location in which the officers, partners, or managers of the issuer primarily direct, control, and coordinate the activities of the issuer. 
    • To establish its “principal place of business”, the issuer must satisfy at least one of four threshold requirements regarding the in-state nature of the issuer’s business.  Under existing Rule 147, the issuer must satisfy EACH of the 80% factors, and the fourth alternative factor (a majority of employees in such state) is not included.    
      • the issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within such state or territory; or 
      • the issuer had at the end of its most recent semi-annual fiscal period prior to the first offer of securities pursuant to the exemption, at least 80% of its consolidated assets located within such state or territory; or
      • the issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to the exemption in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within such state or territory; or 
      • a majority of the issuer’s employees are based in such state or territory. 
    • Under the proposed amendments, issuers that have changed their principal place of business after making sales in an intrastate offering pursuant to proposed Rule 147 would not be able to conduct an intrastate offering pursuant to proposed Rule 147 in another state for a period of nine months from the date of the last sale in the prior state.  This is consistent with the duration of the resale limitation period specified in existing Rule 147(f) and in proposed Rule 147(e). 
    • As defined, an issuer would only be able to have a “principal place of business” within a single state or territory and would therefore only be able to conduct an offering pursuant to amended Rule 147 within that state or territory. Further, as proposed, the provisions of Rule 147 regarding legends and mandatory disclosures to purchasers and prospective purchasers would be retained. 
    • Importantly, under the proposed rules, the issuer’s place of organization (which is important under Rule 147) is no longer relevant to the question of the issuer’s “principal office.” 


Conclusion.  The crowdfunding rules have been described in numerous articles and speeches as facilitating capital formation for small businesses while continuing to protect investors as required by federal and state securities laws.  A brief look at the crowdfunding rules adopted in Colorado (and elsewhere) and Regulation Crowdfunding adopted by the SEC makes it clear that investor protection was paramount in the regulators’ concerns.  Ease of use by small businesses does not appear to have been a priority.  This is consistent with the opinion of SEC Commissioner Michael Piwowar who voted against adoption of the proposed rules, saying: 

  • “[M]any traps for the unwary are hidden in the regulations, creating potential nightmares for small business owners that fail to place regulatory compliance at the top of their business plans.” 

Issuers must understand that crowdfunding offerings will not be inexpensive under federal Reg CF or Colorado law.  If successfully completed many costs will be ongoing.  If unsuccessful, the issuers will still have costs that are independent of the funds raised that will have to be paid. 

The proposed amendments to Rules 504 and 147 may make those offerings even more attractive than previously for capital formation by small business issuers, and may make crowdfunding under the Colorado Crowdfunding Act or Reg CF moot.



On October 30, 2015, the SEC adopted Regulation Crowdfunding (Reg CF) in its Release 33-9974.  That release has received most of the attention from commentators.  A companion release issued the same day, Rel. 33-9973, may ultimately prove to be more useful for capital formation by smaller busijnesses.

Release 933-9973 proposed amendments to Rules 504 and 147 “to facilitate intrastate and regional securities offerings.”  (SEC Rel. 33-9973 (Oct. 30, 2015))  As compared to the 658 page Reg CF release, this was only 168 pages. 

Proposed Rule 504 Amendments.  The SEC proposes to amend Rule 504 to increase the maximum offering from the current $1 million to $5 million, “less the aggregate offering price for all securities sold within the twelve months before the start of and during the offering of securities under this [Rule 504], in reliance on any exemption under section 3(b)(1) [of the 1933 Act], or in violation of section 5(a) of the [1933 Act].”

The proposed Rule 504 amendments would also add a bad actor provision disqualification, relying on Rule 506(d) for the definition of a “bad actor.

The proposed rules would also update Rule 505(b)(2) to refer to section 3(b)(1) of the 1933 Act instead of its current reference to “section 3(b).”  In the proposing release, the SEC also asked for comment on whether there was any continuing need for the Rule 505 exemption (which remains at $5 million) in light of the proposed offering increase to Rule 504.  In seeking comments, at page 67 of the release the SEC noted that issuers relying upon Rule 505 are subject to additional requirements not required under Rule 504,such as: 

  • Rule 505 permits sales to no more than 35 non-accredited investors and an unlimited number of accredited investors, while Rule 504 has no such limitation;  
  • Rule 505 requires the delivery of a disclosure document to non-accredited investors which, like Rule 506, requires substantially the same information as included in a 1933 Act registration statement, while Rule 504 contains no mandated disclosure (although written disclosure is advisable to avoid anti-fraud requirements.  
  • Rule 505 disqualifies bad actors from participating by reference to the provisions of Rule 262 of Regulation A; the proposed rules would tie the Rule 504 bad actor provisions to Rule 506(d).  
  • Rule 505 and Rule 506 permit 1934 Act reporting companies to use the exemption from registration.  Rule 504 does not.  
  • Securities issued under Rule 506 are “covered securities” exempt from state regulation (except filing requirements and fee payment), and thus more useful than Rule 505.  Securities issued under Rules 504 and 505 are not “covered securities.”

In re Montage Technology Group Limited Securities Litigation: Motion to Dismiss Denied In Case Alleging Undisclosed Related Party Dealings

In In re Montage Technology Group Limited Securities Litigation, 2015 BL 22394 (N.D. Cal. Jan. 29, 2015), Martin Graham, individually and on behalf of the class (collectively, “Plaintiffs”) filed suit against Montage Technology Group Limited (“Montage”) and individual defendants Yang, Tai, and Voll (collectively, “Defendants”) for securities purchased between September 25, 2013 and February 6, 2014. The United States District Court for the Northern District of California denied Defendants’ motion to dismiss Plaintiffs’ consolidated amended complaint (“Complaint”), holding Plaintiffs properly stated claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. 

According to the allegations in the Complaint, Plaintiffs asserted that Defendants committed fraud by failing to disclose in their SEC filings that dealings with LQW were related party transactions.  Dealings with LQW accounted for between 50 and 71 percent of Montage’s revenue. LQW was owned and controlled by Shanghai Montage Microelectronics Co. Ltd. (“SMMT”), an undisclosed affiliate of Montage.

The court concluded that the Defendants “essentially concede that LQW was a related party prior to July of 2012, when Lei Wu - an officer of Montage - was a majority owner of SMMT.” Thereafter, while the connection was “somewhat more attenuated” the alleged facts nonetheless gave rise “to the plausibility of a continued close relationship.”   

For a plaintiff to adequately assert a claim under § 10(b) and Rule 10b-5, the plaintiff must allege facts that show (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.

The court considered whether the complaint sufficiently alleged a misleading statement or omission, causation and scienter. With respect to the misleading statement, the court reasoned that without knowledge of the relationship between Montage and LQW, investors were unaware that most of Montage’s revenue was generated through related party transactions. This created a substantial likelihood that a reasonable investor would find the omission significantly altered the “total mix of information.” 

Scienter may be shown with particularized facts indicating motive and opportunity to commit fraud. The court found that the complaint sufficiently alleged a strong inference that Defendants knew, or were deliberately reckless in not knowing, that the SEC filings were false or misleading. Montage and SMMT had a close relationship, the companies shared an office and phone number, and employees had knowledge that a relationship existed between the companies. As a result, the court concluded that “[t]hese facts, taken together, raise a ‘strong inference’ that the defendants were aware of facts that made their SEC filings false or misleading." 

The court also found Plaintiffs properly alleged loss causation through allegations that (1) Montage’s omission of related party transactions led to inflated stock prices, (2) the market became aware of fraud after release of the Gravity Report, and (3) the price of Montage’s stock fell more than 25% in the two days following the report’s release.

Finally, Plaintiffs alleged that the individual defendants named were officers of Montage and those officers signed the allegedly fraudulent SEC filings at issue. The court held this was sufficient to state a claim for control person liability in violation of § 20(a).

Accordingly, the court denied Defendants’ motion to dismiss.

The primary materials for the post are available on the DU Corporate Governance Website.



In re Genworth Fin. Sec. Lit.: District Court Denies Motion to Dismiss in Securities Fraud Case

In In re Genworth Fin. Sec. Lit., 14 Civ. 2392 (S.D.N.Y. June 15, 2015), the United States District Court for the Southern District of New York denied Genworth Financial, Inc. (“Genworth”), Michael D. Fraizer, and Martin P. Klein’s (collectively, “Defendants”) motion to dismiss a second amended complaint filed by lead plaintiff, Ashley M. Price, and other purchasers of Genworth securities (collectively, “Plaintiffs”) in a class action suit alleging violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The court found the complaint adequately alleged claims for securities fraud. 

According to the complaint, Genworth, through subsidiaries, provided insurance and wealth management services in twenty-five countries. In 2011, Genworth suffered increasing losses and mounting claims, resuting in an increase in loss reserves.  In April 2012, Genworth disclosed this information, causing share prices to drop 23%.   [I took out the repeating words, such as disclose]  Plaintiff alleged that the company “suppressed the information” concerning the increase.  

Plaintiffs filed a class action complaint, focusing on Genworth’s Australian subsidiary and alleging violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Specifically, Plaintiffs alleged they purchased shares of Genworth common stock at an inflated price because Defendants purposefully and willfully misstated Genworth’s income and assets. 

To prove securities fraud, a party must show: (1) a material misrepresentation (or omission); (2) scienter; (3) a connection with the sale of purchase of a security; (4) reliance; (5) economic loss; and (6) loss causation. 

In a conclusory fashion, the court found that Plaintiffs had adequately alleged the elements of a securities claim.  The company allegedly misstated that:

  • the 2011 flood events in Queensland, and higher interest rates and living costs, an elevated currency, and lower consumer spending are being absorbed in Genworth's loss ratios; housing markets in Canada and Australia are sound overall; and in Australia, "the loss ratio remained flat at 48% sequentially, reflecting the slower recovery in Queensland from flooding earlier in the year and continued pressure from higher interest rates, increased living costs, lower consumer spending, and a strong Aussie dollar, which impacts tourism and exports." 

The court also found sufficient evidence of the “personal and wrongful knowledge” of the individual defendants who, “as ‘high-level executives and/or directors’” and "by virtue of [the] responsibilities and activities as a senior officer” were “’privy to and participated in the creation, development and reporting’ of Genworth's false and misleading statements.”  Moreover, the court acknowledged that while some statements contained forward-looking language, “they are statements of current condition, and are therefore not protected by the safe-harbor defense.” 

Accordingly, the court denied Genworth’s motion to dismiss.   

The primary materials for this case can be found on the DU Corporate Governance website.   


FDIC Extender Statute Preempts Statutes of Limitations and Statutes of Repose

In F.D.I.C. v. RBS Securities Inc., 2015 WL 4745032 (5th Cir. 2015), Federal Deposit Insurance Corporation (“FDIC”) filed two separate suits against RBS Securities, Inc., Goldman, Sachs & Co. and Deutsche Bank Securities, Inc. (collectively the “Appellees”) and other financial institutions alleging claims of securities fraud, alleging that they made false and misleading statements in selling and underwriting residential mortgage backed securities.  

The district court granted judgment on the pleadings in favor of the Appellees, holding that the FDIC Extender Statute, 12 U.S.C. § 1821(d)(14), preempted only state statutes of limitations, but not state statues of repose – drawing a distinction between the two categories of limitation statutes.  The 5th Circuit reversed, concluding that the FDIC Extender Statute preempted limitations periods and periods of repose.   

According to the complaint, Guaranty Bank invested in residential mortgage backed securities (“MBS”) sold by RBS in 2004 and 2005. These packages of residential mortgages are sold by the original lender to a trust–transferring ownership of the mortgages themselves and the right to monthly payments on those mortgages to the trust. Investors, such as Guaranty Bank, then purchased interests in the form of certificates from the trust.  On August 21, 2009, amidst the global financial crisis, the Office of Thrift Supervision closed Guaranty Bank and the FDIC was appointed receiver under the terms of the Federal Deposit Insurance Act.

On August 17, 2012, the FDIC filed its suits alleging that, in underwriting and selling the residential mortgage backed securities to Guaranty Bank, the Appellees committed securities fraud under the Securities Act of 1933 and the Texas Securities Act. The allegation of fraud was based on material misrepresentations and omissions about the quality of the MBS. 

Appellees, in their separate cases, moved for judgment on the pleadings, arguing the Texas statute of repose barred the FDIC’s claims. Although the FDIC Extender Statute allowed for the filing of an action within three years after the FDIC’s appointment as receiver, Appellees asserted that the Statute did not preempt the five year statute of repose included in the Texas Securities Act.  

To support their argument, appellees relied on CTS Corp. v. Waldburger, 134 S.Ct. 2175 (2014).  There the Supreme Court found that a provision of CERCLA, 42 U.S.C. §9658, preempted state statutes of limitations but not statues of repose. The district court relied on this case in granting Appellees’ motions for judgment on the pleadings and dismissed the FDIC’s claims as barred by the Texas statute of repose. 

The 5th Circuit, however, distinguished the case.  Analysis of the text, structure and purpose of the FDIC Extender Statute, according to the court, evinced an intent by Congress to displace any limitations period that would interfere with the FDIC’s post-appointment three-year period to investigate potential claims – regardless of the statute’s characterization as a statute of limitation or statute of repose. As the court reasoned: 

  • The text and structure of the FDIC Extender Statute provide for preemption of all limitations periods—no matter their characterization as statutes of limitations or statutes of repose—to the extent that they provide less than three years from the date of the FDIC’s appointment as receiver to bring claims.14 That is also the only interpretation consistent with the statute’s purpose of providing the FDIC with a minimum period of time to investigate and evaluate potential claims on behalf of a failed bank. The contrary interpretation would thwart the purpose of Congress by truncating the FDIC’s statutory three-year minimum period and leaving tenebrous the applicable limitations period where Congress meant to elucidate it. 

Accordingly, the Court reversed the judgment of the district court and remanded the case for further proceedings.

The primary material for this case can be found on the DU Corporate Governance website


Supreme Court Defining Personal Benefits in the Context of Insider-Trading Liability

The Race to the Bottom is following developments in United States of America v. Todd Newman et al, No. 15-137, July 30, 2015. On July 30, 2015, the Solicitor General entered a petition for a writ of certiorari to review the Second Circuit Court of Appeal’s December 10, 2014 judgment reversing securities fraud convictions for Todd Newman, a portfolio manager at Diamondback Capital Management, LLC. and Anthony Chiasson, a portfolio manager at Level Global Investors, L.P., (together, the “Respondents”). 

A jury convicted the Respondents of engaging in insider trading with respect to shares of Dell and Nvidia.  The government alleged that the information came from insiders who did not benefit from the disclosure but were friends with the recipients.  The Second Circuit reversed the conviction, reasoning mere friendship could lead to an inference of personal benefit only if evidence was generally akin to quid pro quo and that an insider could only benefit from a relationship if “meaningfully close.”

The Solicitor General argued that the court of appeals departed from the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983), which held that when an insider breached his or her duty to the corporation when benefiting from the disclosure of material non-public information. In addition, however, the Court also acknowledged that “[t]he elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.”  In doing so, “[t]e tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.” 

Solicitor General argued that the Second Circuit’s decision warranted review based on its redefinition of personal benefit in the context of personal relationships.  The shift would harm the fair and efficient operation of securities markets and serve to undermine the work of analysts who play by the rules. Insider trading erodes public confidence in the integrity of securities markets, and disadvantages legitimate analysts pursuing research and modeling based on authorized information.

The Solicitor General also pointed out that the Second Circuit’s decision conflicted with the reasoning of the 7th Circuit (see SEC v. Maio, 51 F.3d 623 (7th Cir. 1995)) and a  Ninth Circuit opinion that specifically rejected the Newman analysis. See United States v. Salman, No. 14-10204, 2015 WL 4068903 (9th Cir. July 6, 2015. The circuit split will lead to an uneven enforcement of security law against individuals participating in the same nationwide capital markets. 

The primary materials for this post can be found on the DU Corporate Governance website.


In re Family Dollar Stores, Inc. Stockholder Litigation: Reasonable Probability of Success Under Revlon

In In re Family Dollar Stores, Inc. Stockholder Litigation, the shareholders of Family Dollar Stores, Inc. (“Plaintiffs”) sued the Family Dollar Stores, Inc. board of directors (“Family”) and Dollar Tree Inc. (“Tree”) (collectively the “Defendants”), with a core claim of breach of fiduciary duty. The court found the Plaintiffs failed to demonstrate a reasonable probability of success on any of their claims, the existence of irreparable harm, or that the balance of the equities favored the relief sought.   

According to the complaint, Family and General began discussing a potential merger in 2013, although testimony suggested that “General was not ‘very motivated or anxious to do a transaction” with Family.’” In the Spring of 2014, Tree and Family entered into merger discussions. Any merger would require antitrust approval by the Federal Trade Commission (“FTC”), a significant concern. In July 2014, Family and Tree executed a merger agreement in which Tree would acquire Family for a price that eventually reached $76 per share.

To ensure FTC approval, Tree agreed to divest as many of its retail stores as necessary. Shortly thereafter, General made two bids to acquire Family, with the second including a price of $80 per share and a commitment to divest up to 1,500 of its stores in order to facilitate FTC approval. At the advice of its financial and legal counsel, Family did not engage General in discussions regarding its offer. In response, General commenced a tender offer at $80 per share.

The stockholders of Family then filed suit seeking a preliminary injunction of the Family stockholder vote on the proposed merger until: (1) the Board properly engaged and made a good faith effort to achieve a value-maximizing transaction with General; and (2) corrective disclosures were made. With regard to the first basis for injunctive relief, Plaintiffs asserted the Board breached its fiduciary duties under the Revlon standard in three ways: (1) running the sales process with minimum supervision; (2) entering a merger agreement with Tree before informing General; and (3) failing to negotiate with General after receiving its revised offer. Plaintiffs’ premised their second basis for injunctive relief on the Defendants’ failure to disclose seven categories of purportedly material information in its Proxy.

To obtain a preliminary injunction a plaintiff must demonstrate (i) a reasonable probability of success on the merits; (ii) irreparable harm absent interim relief; and (iii) that the balance of the equities favors the relief requested. Allegations of a breach of fiduciary duties in the context of a sale of corporate control by the directors of a Delaware corporation requires analysis under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.’s enhanced scrutiny standard. This standard charges directors with acting in a manner necessary to obtain the highest value reasonably attainable for shareholders. Directors bear the burden of proving they were adequately informed and acted reasonably.

The court found the board had proper motivation to maximize value for Family’s stockholders. The court took particular notice of the fact that ten of the eleven Family directors were independent, and that Levine’s ownership of 9 million Family shares was economic incentive to maximize company value. Finally, the court noted Family’s numerous discussions with General dating back to 2013 exploring a potential transaction.

Addressing Plaintiffs’ first basis for injunction, the court held the Plaintiffs did not demonstrate a reasonable probability of success on the merits of their Revlon claims. First, the court quickly dismissed the Plaintiffs’ arguments concerning supervision and the failure to inform General of the sales process. The court then found that Defendant acted reasonably in not engaging General in discussions.  The Court reasoned that the antitrust risks associated with General’s offer made it a financially superior offer on paper, but a financially inferior transaction “in the real world.” The court noted, among other things, the advice of the Family board’s financial advisor giving the General offer a 60% chance of failing the FTC’s antitrust review. The court found that the General revised offer failed to adequately address the concerns over the antitrust issues. 

Addressing the second basis for injunction, the court found the Plaintiffs failed to demonstrate a reasonable probability of success. The court reasoned the disclosure claims lacked merit because the statements identified by the Plaintiffs as “omissions and misleading statements” were “misapprehensions of the record, speculation, self-flagellation, or immaterial minutiae.”

Finally, the court found no threat of irreparable harm because there was no preclusive or coercive provision in the Family-Tree merger agreement preventing General or other third-parties from submitting a better proposal. The court also determined the risks of a preliminary injunction outweighed any benefits of delaying the stockholder vote on the Family-Tree transaction.

Accordingly, the court denied the Plaintiffs’ motion for preliminary injunction.

The primary material for this case can be found on the DU Corporate Governance website


Rajat K. Gupta: No Luck with Motion to Vacate in Wake of Newman

In United States v. Gupta, 11 Cr. 907, 2015 BL 212998 (S.D.N.Y. July 02, 2015), the United States District Court for the Southern District of New York denied Rajat Gupta’s (“Gupta”) motion to vacate his sentence and the judgment against him, filed pursuant to 28 U.S.C. § 2255 (Motion Attacking Sentence).      

A jury convicted Gupta of one count of conspiracy and three counts of substantive securities fraud on June 15, 2012, after which Gupta filed a series of appeals and motions, including a motion to vacate pursuant to 28 U.S.C. § 2255. Gupta’s most recent motion relies on a recent case, United States v. Newman, 773 F.3d 438 (2d Cir., 2014), which held that to convict a remote tippee of securities fraud, there must be proof beyond a reasonable doubt that the tippee knew an insider disclosed confidential information and did so in exchange for personal benefit. Therefore, under Newman, a tipper’s intention to benefit a tippee is sufficient to meet the benefit requirement, unless a remote tippee is involved.

Gupta argued the personal benefit element of the § 10(b) insider trading violation claim against him was not sufficiently proven at trial and further argued that Newman served to bolster his position. Specifically, Gupta argued Newman’s restriction on the scope of evidence that could be used to infer personal benefit opened the door to a defense that had beem futile under previous case law.

A motion under Section 2255 is not a substitute for appeal and will only be successful upon a showing of either actual innocence or good cause for failing to raise the issue and resulting prejudice. Relevant here, cause and prejudice can be shown by demonstrating that raising the issue on direct appeal was futile in light of case law at the time.    

The court found two major flaws with Gupta’s arguments. First, the court noted the difference between Newman, which concerned a remote tippee’s liability, and Gupta’s case. In Newman, the plaintiff was the recipient of information provided to an employee by a tipper. Gupta, the court pointed out, was himself the tipper, providing confidential information for the personal benefit of Raj Rajaratnam. Because Gupta was the tipper and not a remote tippee, the court concluded the Newman standard was not relevant to Gupta’s conviction. 

The court also held Gupta’s argument moot, even if the standard articulated in Newman applied. While Gupta argued the prosecution did not prove beyond a reasonable doubt that he acted for his own personal gain, the court found it clear, given Gupta’s ownership stake and close ties with Rajaratnam’s hedge fund, that Gupta would benefit from an immediate financial gain by providing the information to Rajaratnam.

Accordingly, the court held Newman, was inapplicable to Gupta’s case. The court further held that if Gupta’s reading of Newman was accurate, his claim lacked merit. The court therefore denied Gupta’s Section 2255 motion in its entirety. 

 The primary materials for this case may be found on the DU Corporate Governance website.


DC Circuit Won't Hear Bid To Revive SEC Conflict Minerals Rule

In the most recent step in the long journey of the legal battle over the conflict minerals rule, the DC Circuit Court on November 9th denied a petition to conduct an en banc hearing of the courts 2-1 August decision in the conflict minerals case.  That ruling found that the provision of the rule requiring companies subject to the rule to identify their products as conflict or non-conflict free violated the First Amendment.  (details of the holding and the rule here here and here).

Regardless of one’s opinion of the merits of the conflict minerals rule, the court’s refusal to hear the case is upsetting.  It leaves the law governing compelled commercial speech in a mess.  The decision must be read in conjunction with the recent decision in the American Meat case which upheld country of origin labeling rules. (that case discussed here)

The critical issue is what standard of review should be applied to compelled commercial speech, an issue with a complicated legal history.  There has long been disagreement over whether courts should apply a lower standard of protection for “commercial speech” than for other forms of expression, and whether the government should be required to explain its motives for compelling companies to say certain things. While it is uncontroversial to require companies to be truthful in their advertising, and the Securities and Exchange Commission requires a whole raft of disclosures in offering documents and other information provided to investors, those rules generally have the goal of preventing consumer deception.  It has proved much harder to determine how to test regulations that aim not to prevent deception but instead to provide information that contains a “message” to consumers.  In this area the law has evolved and not very cleanly.

In brief overview, the most stringent level of review applied to compelled commercial speech was established in Central Hudson case and tests:

(1) whether the speech at issue concerns lawful activity and is not misleading;

(2) whether the asserted government interest is substantial; and, if so,

(3) whether the regulation directly advances the governmental interest asserted; and

(4) whether it is not more extensive than is necessary to serve that interest.

In this analysis, the government bears the burden of identifying a substantial interest and justifying the challenged restriction: “The government is not required to employ the least restrictive means conceivable, but it must demonstrate narrow tailoring of the challenged regulation to the asserted interest — a fit that is not necessarily perfect but reasonable; that represents not necessarily the single best disposition but one whose scope is in proportion to the interest served.

This stringent standard of review was softened considerably in Zauderer v. Office of Disciplinary Counsel in which the Court found that Central Hudson scrutiny did not apply to  a “purely factual and uncontroversial” disclosure required in order to correct an otherwise misleading advertisement.  The Court reasoned that advertisers’ rights are protected so long as the compelled disclosure of truthful information reasonably relates to the state’s interest in preventing consumer deception. 

Recently, in American Meat Institute v. USDA the en banc D.C. Circuit broadened the reach of Zauderer finding that its standard of review applies to “factual and uncontroversial” disclosures mandated by the government for any purpose, not just those aimed at prevented consumer deception.  In doing so it referred directly to the earlier holding in the conflict minerals case striking down the requirement of “conflict-free” labeling on the basis that Zauderer applied only to compelled speech aimed at preventing deception.  The American Meat court stated:

To the extent that other cases in this circuit may be read as holding to the contrary and limiting Zauderer to cases in which the government points to an interest in correcting deception, we now overrule them.1See, e.g., Nat’l Ass’n of Mfrs. v. SEC, 748 F.3d 359, 370-71 (D.C. Cir. 2014); Nat’l Ass’n of Mfrs. v. NLRB, 717 F.3d 947, 959 n.18 (D.C. Cir.2013); R.J. Reynolds Tobacco Co. v. FDA, 696 F.3d 1205, 1214 (D.C. Cir. 2012). 

So Where Does This Leave Us?

By refusing to hear the conflict minerals rule case en banc the DC Circuit has left the law concerning compelled disclosure in a muddle.  According to American Meat, the reach of Zauderer has been extended –but how far?  The justification in the conflict minerals case for not applying more lenient Zauderer scrutiny is that the statement was not factual and uncontroversial.  Because of this, the government must show that the required disclosure will have the desired effect—so in the case of the conflict minerals rule the government would have to show that the disclosure would lead to a decrease in the violence in the DRC—a burden it clearly could not meet.

This all leaves the fate of many other compelled disclosures in limbo.  The obligation of companies to disclose information about their industry and climate change has been very much in the news of late—but could mandated disclosure in this area pass muster under the current standards established by the DC Circuit?  It seems unlikely.  Other examples abound and it is not a stretch to see how the current developments in the DC Circuit pose serious impediments for corporate social responsibility advocates who seek to use compelled disclosures to address a whole host of human rights issues.

Much is at stake.  What is the role of the First Amendment in regulating commercial speech?  Does it serve as a restraint on government such that the government must show its regulations achieve some public goal?  Or conversely, does it provide power to the government allowing it to forced companies to disseminate information in the interest of broader speech?

The real question is now what?  An appeal to the Supreme Court is possible but even if an appeal is brought there is no guarantee that the Court would take it.   If the ruling is not appealed or if the appeal is rejected, the matter would go back to the U.S. District Court “for further proceedings.”  Those proceedings could be a simple as stating that the “conflict free” descriptor cannot be required, along with a remand of the rule to the SEC for revision.   However, some are proposing that when the case is remanded to the U.S. District Court, the parties might seek to have other issues considered, a fight that would extend the legal challenge even further.

While the battle continues, it is highly likely that industry groups such as the US Chamber of Commerce will see the refusal to rehear the conflict minerals case as creating an opportunity to challenge other disclosure requirements.  Perhaps future such challenges will provide the opportunity for the DC Circuit to clean up the mess that exists in the current state of the law regarding compelled disclosure.  We can only hope.


Another Front Opens in the Disclosure Wars

Readers of this blog are aware of the ongoing fight over compelled corporate disclosure exemplified by the fractious history over the conflict minerals rule.  A new front has now been opened by New York Attorney General Eric Schneiderman who has moved under the Martin Act to open an investigation over whether Exxon Mobile mislead the public and shareholders about the perils of climate change.

Schneiderman subpoenaed Exxon demanding extensive financial records, emails and other documents to probe the company's knowledge and disclosures about climate change going back to the 1970s. The investigation seems to have been spurred by stories in Inside Climate News and the Los Angeles Times that the Exxon’s s own scientists had raised concerns about global warming decades ago that the company executives contradicted. 

Pressure has also come from, among others, presidential candidate Bernie Sanders who on Oct 20th wrote a letter to U.S. Attorney General Loretta Lynch stating that “it appears that Exxon knew its product was causing harm to the public, and spent millions of dollars to obfuscate the facts in the public discourse.” Sanders’s letter states that the recent investigation shows that “top Exxon scientists concluded both that climate change is real and that it was caused in part by the carbon pollution resulting from the use of Exxon’s petroleum-based products,” as early as 1977.

Under the Martin Act, the state must prove that a company deceived the public by misrepresenting or omitting a material fact in the offering of securities.  Unlike many securities laws, the Martin Act does not require proof of intent to deceive is required to bring a claim, and prosecutors do not even need to show that anyone was in fact defrauded. The act allows for criminal as well as civil charges.  The theory of the probe seems to be that if Exxon believed for decades that climate change was real and that they were in part responsible for it, the company’s failure to inform the public of that information and to instead support research that contradicted that information was fraudulent.

In response to the probe, Exxon has said it has worked on climate science in a transparent way for nearly 40 years and has regularly disclosed the business risks of climate change to investors for years.  On Wednesday, Oct. 21, the company issued a statement regarding the issue, saying that “media and environmental activists’ allegations about the company’s climate research are inaccurate and deliberately misleading.”

According to ExxonMobil’s vice president of public and government affairs, Ken Cohen, “activists deliberately cherry-picked statements attributed to various company employees to wrongly suggest definitive conclusions were reached decades ago by company researchers.”

So What is the Fight Really About?

On the factual front, the fight is about what Exxon knew about the causes of climate change and whether they mislead investors by failing to disclose information adequately.  According to Inside Climate news in the early days of climate change research:

  • the company launched its own extraordinary research into carbon dioxide from fossil fuels and its impact on the earth. Exxon’s ambitious program included both empirical CO2 sampling and rigorous climate modeling. It assembled a brain trust that would spend more than a decade deepening the company’s understanding of an environmental problem that posed an existential threat to the oil business.
  • Then, toward the end of the 1980s, Exxon curtailed its carbon dioxide research. In the decades that followed, Exxon worked instead at the forefront of climate denial. It put its muscle behind efforts to manufacture doubt about the reality of global warming its own scientists had once confirmed. It lobbied to block federal and international action to control greenhouse gas emissions. It helped to erect a vast edifice of misinformation that stands to this day.
  • In a 2012 PBS interview, Steve Coll, a staff writer at The New Yorker and author of Private Empire: ExxonMobil and American Power, said that the radical thing the Exxon did that really altered the debate around climate change was to go after the science.
  • He said that while many oil companies lobbied against past climate accords, such as the 1997 Kyoto Protocol, on “economic and fairness grounds,” Exxon took a different tact, based in large part, according to Coll, on the “personal conviction of the chief executive, Lee Raymond.”

But Where is the Law?


Even Mark Zuckerberg Has to Follow the Rules  

The recent case Espinoza v. Zuckerberg proves even the powerful have to follow the rules.  In a case of first impression the Delaware Chancery Court addressed the question:

Can a disinterested controlling stockholder ratify a transaction approved by an interested board of directors, so as to shift the standard of review from entire fairness to the business judgment presumption, by expressing assent to the transaction informally without using one of the methods the Delaware General Corporation Law prescribes to take stockholder action?

The Facts in Brief

In August, the board of directors of Facebook meet and voted to increase the compensation paid to members of its audit committee. Plaintiff Espinoza filed a derivative complaint challenging the decision to increase compensation as breach of fiduciary duty “for awarding and/or receiving excessive compensation at the expense of the Company,” a waste of corporate assets, and unjust enrichment.

When the suit was filed the parties agreed that although the compensation committee had discussed the matter, the approval was given by the board and therefore would be governed by the entire fairness standard of review as a self-dealing transaction.  After the filing, Mark Zuckerberg, who did not receive any of the disputed 2013 compensation and who controlled over 61% of the voting power of Facebook’s common stock, expressed his approval of the 2013 compensation for the non-management directors in a deposition and an affidavit.

Defendants then sought summary judgment on the theory that Zuckerberg, in his capacity as a disinterested stockholder, ratified the 2013 compensation, thereby shifting the standard of review governing that transaction from entire fairness to the business judgment presumption. Defendants also seek to dismiss the waste claim for failure to state a claim upon which relief can be granted. 

The Decision

As stated by the court “The fundamental issue here is whether Zuckerberg’s approvals were in a form sufficient to constitute stockholder ratification” when “Zuckerberg did not make use of a formal method of expressing stockholder assent, namely by voting at a stockholder meeting or acting by written consent in compliance with Section 228 of the Delaware General Corporation Law.”

Defendants argued that informal ratification by the controlling shareholder was sufficient, relying on general principals of agency law.

After walking through the history of what is now Section 228 of the Delaware General Corp. Law, the court concluded that formalities must be followed for shareholder action by written consent to be valid, noting: 

  • the provisions of the DGCL governing the ability of stockholders to take action, whether by voting at a meeting or by written consent, demonstrate the importance of ensuring precision, both in defining the exact nature of the corporate action to be authorized, and in verifying that the requirements for taking such an action are met, including that the transaction received enough votes to be effective. They also demonstrate the importance of providing transparency to stockholders, whose rights are affected by the actions of the majority. In particular, stockholders have the right to participate in a meeting at which a vote is to be taken after receiving notice and all material information or, in the case of action taken by written consent, to receive prompt notice after the fact of the action taken.  


  • where formal structures govern the collective decision-making of stockholders who coexist as principals.,,,,[t]hese formalities serve to protect the corporation and all of its stockholders by ensuring precision, both in defining what action has been taken and establishing that the requisite number of stockholders approved such action 

Finally, the court dismissed the motion for summary judgement on all but the waste claim, stating: 

  • I therefore conclude that stockholders of a Delaware corporation—even a single controlling stockholder— cannot ratify an interested board’s decisions without adhering to the corporate formalities specified in the Delaware General Corporation Law for taking stockholder action. 

Consequently, neither Zuckerberg’s affidavit nor his deposition testimony ratified the Facebook board’s decision to approve the 2013 Compensation, which decision remains subject to entire fairness review because a majority of the board was personally interested in that transaction. The entire fairness standard of review requires defendants to establish that the “transaction was the product of both fair dealing and fair price.” Because defendants relied solely on a ratification defense, they did not attempt to produce evidence of entire fairness sufficient to show an entitlement to judgment as a matter of law, nor have they demonstrated that there is no genuine issue of material fact as to the entire fairness of the 2013 Compensation. 

What to make of this case?  As we know from piercing cases, formalities matter.  Even the rich and powerful must pay attention. 



Shareholder Proposals & Staff Legal Bulletin No. 14H (CF): Trinity Guidance (Part 11)

In perhaps a bit of surprise, the guidance also addressed the test articulated in Trinity v. Wal-Mart.  There the Third Circuit found that, in applying the public policy exception to the ordinary business exclusion, “the subject matter of its proposal must ‘transcend’ the company’s ordinary business.” The court relied on some out of context language to attributed to the staff a position that was, in fact, inconsistent with the views of the staff.

The staff clearly and bluntly disavowed the test.  “This two-part approach differs from the Commission’s statements on the ordinary business exclusion and Division practice.”  The staff reiterated the position that proposals seeking board review of a matter constituted “ordinary business.”  Id. (“We believe our analysis in this matter is consistent with the views the Commission has expressed on how to analyze proposals under the ordinary business exclusion, i.e., the analysis should focus on the underlying subject matter of a proposal’s request for board or committee review regardless of how the proposal is framed.”)

In commenting on the case, the staff expressed concern with the impact of the reasoning. 

  • Although we had previously concluded that the significant policy exception does not apply to the proposal that was submitted to Wal-Mart, we are concerned that the new analytical approach introduced by the Third Circuit goes beyond the Commission’s prior statements and may lead to the unwarranted exclusion of shareholder proposals.   

The staff noted that the concurring opinion had it right.  Id. (“Whereas the majority opinion viewed a proposal’s focus as separate and distinct from whether a proposal transcends a company’s ordinary business, the Commission has not made a similar distinction.  Instead, as the concurring judge explained, the Commission has stated that proposals focusing on a significant policy issue are not excludable under the ordinary business exception “because the proposals would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote.”).

The guidance removes an un-necessary analytical complication from the (i)(7) area.  The "ordinary business" and "public policy" standards are mangled enough without these sorts of additional distractions.     

Thus, a proposal may transcend a company’s ordinary business operations even if the significant policy issue relates to the “nitty-gritty of its core business.”  Therefore, proposals that focus on a significant policy issue transcend a company’s ordinary business operations and are not excludable under Rule 14a-8(i)(7).32  The Division intends to continue to apply Rule 14a-8(i)(7) as articulated by the Commission and consistent with the Division’s prior application of the exclusion, as endorsed by the concurring judge, when considering no-action requests that raise Rule 14a-8(i)(7) as a basis for exclusion.


Shareholder Proposals & Staff Legal Bulletin No. 14H (CF): A Complete Copy of the Proposal (Part 10)

The guidance contains a number of useful references that hopefully will play a more important role in the no action process. Footnote 15 indicated that at least sometimes the staff would expect to receive the alternative proposal that management planned to submit.  As the guidance noted: 

  • We remind companies that the staff may need a complete copy of a company’s proposal to evaluate a no-action request under Rule 14a-8(i)(9) and that the staff may not be able to agree that the company has met its burden of demonstrating that a shareholder proposal is excludable if those materials are not included with the company’s no-action request.  This same principle applies when the staff evaluates no-action requests under Rule 14a-8(i)(10). 

In submitting requests for exclusion under subsection (i)(9), companies are not explicitly required to submit the competing proposal.  As a result, the competing proposal, once drafted, can include terms and limitations that differ from the shareholder proposal (or at least the intent of the shareholder proposal).  The guidance suggests that companies that do not submit the competing proposal may not receive the requested no action relief, although the cirsumstances when this will occur are not specified.  At a minimum,  the failure to do so raises some additional risk.